Index Investing

[specuvestor]

The excellent classic 30 year old literature to look at is this (disclaimer: I agree with probably 90% of it):
https://www8.gsb.columbia.edu/articles/c...rinvestors

IMHO index investing is as sexy as the nifty fifties or the portfolio insurance or dot coms. As always there are some fundamental truths in it that is extrapolated to stratosphere. I agree with Buffett though that if one doesn't want to spend effort, ETF are good investment alternatives.

Time is the enemy of the mediocre. Over time most ETF of say 3-5 years life you can see that they underperform their respective indices by the fees compounded and unlike managed funds that are worth their salt, of no way to recover.

If investment outperformance over a cycle is less than 0.3% annualised, then index funds should be the next best thing since sliced bread

Hi specuvestor, can u elaborate what you mean?

Anyway, spdr STI etf has annualised 1 yr returns of 5% as at Nov 16, which is not bad.

If u are looking for outperformance, then index investing is not the place to be in. If u are looking for a very lazy way to invest, index investing may be the place for u.

For the past 5 years 2012-2016 (Note FTSE calculation started in 2008), STI returned 27.9% (5% annualised) while SPDR returned 24.4% (4.5% annualised). This 50bps gap will continue to increase next 5 years and it will NEVER recover because that's the cost of the ETF and low tracking error, not outperformance, is the methodology.

For an absolute return fund worth its salt, over an up-down cycle, approximately from 1 Jan 2012 to 21 Jan 2016 (at cycle low), it should be able to beat 8.3% STI return over that 4+ years after fees, especially over and above the 50bps compounded "sliced bread" cost for ETF. That I think is the bottomline and a reference for VBs here.

By 2018 STI ETF will have a 10 year track record of underperforming FTSE STI by >5% and academics can argue again whether it makes sense.

Going forward I think that should be the value of active fund management vs ETF, not comparing just upside, just downside or tracking error, but over a full cycle. Unfortunately I think most long and hedge funds, as well as investors which don't give the right mandate or timeline, don't get this but focus on the latest trends or themes... resulting in the current bad repute.

What Seth Klarman has to say about ETF:

Perhaps the most distinctive point he makes — at least that finance geeks will appreciate — is what he says is the irony that investors now “have gotten excited about market-hugging index funds and exchange traded funds (E.T.F.s) that mimic various market or sector indices.”
He says he sees big trouble ahead in this area — or at least the potential for investors in individual stocks to profit.
“One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to ‘lock in’ today’s relative valuations between securities,” Mr. Klarman wrote.
“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”
To Mr. Klarman, “stocks outside the indices may be cast adrift, no longer attached to the valuation grid but increasingly off of it.”
“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”

https://www.nytimes.com/2017/02/06/busin....html?_r=0

Another 2 detractors of ETF... Howard Marks and Paul Singer:

https://www.oaktreecapital.com/insights/...arks-memos

and

By Simone Foxman
(Bloomberg) -- Billionaire Paul Singer is warning of a
growing and menacing threat: passive investing.
“Passive investing is in danger of devouring capitalism,”
Singer wrote in his firm’s second-quarter letter dated July 27.
“What may have been a clever idea in its infancy has grown into
a blob which is destructive to the growth-creating and
consensus-building prospects of free market capitalism.”
Almost $500 billion flowed from active to passive funds in
the first half of 2017. The founder of Elliott Management Corp.
contends that passive strategies, which buy a variety of
securities to match the overall performance of an index, aren’t
truly "investing" and that index fund providers don’t have
incentive to push companies to change for the better and create
shareholder value.
Elliott, whose main hedge funds manage $33 billion, is best
known for its high-profile activist and distressed wagers,
including leading a group of holdout creditors seeking repayment
for positions in Argentine debt. One of Singer’s most recent
campaigns -- a bid to buy power distributor Oncor Electric
Delivery Co. -- has pitted him against billionaire Warren
Buffett.


No Voice

“In a passive investing world, small shareholders have
little-to-no voice and no realistic possibility of banding
together, while the biggest shareholders have no (repeat, no)
skin in the game so long as the money manager does not
underperform the index by five-hundredths of a percentage point,
in which case the customer calls up the money manager and starts
yelling,” the letter said. There’s a real likelihood that
passive investing “and its apparent stability, is unsustainable
and brittle.”

-snip-

[HyperionTree]

Here is an interesting article by Cullen Roche about what he considers to be "The Biggest Risk of Passive Investing"

http://www.pragcap.com/the-biggest-risk-...investing/

One other factor is that USD nominal interest rates have been going lower and lower after peaking in 1985. That gives 30+ years of downtrend. This should contribute to ETFs outperforming.

Interestingly, Tree said that when the Fed printed money to buy bonds, the money didn't flow into the economy. Instead the money got clogged up in the stock market and in the property market. This is evident by the low velocity of money observed in US. If money is clogged up, then QE had failed to serve its purpose of revitalizing the economy. Instead, stock market and property market bubbles are created around the world. If money is stuck in stocks, and you exclude stocks and property values in calculating inflatoin, of course inflation won't increase during a period of aggressive money printing.

Hyperion notes that while retail went for ETFs, institutions went for tech via the alternative assets route. Many pension funds funded private equity and venture capital funds to invest in technology companies. From the start-up space, to IPOs like Snapchat and tech giants like Amazon, the tech sector is very overvalued. As such, for the last 5 years, the only active managers that beat the indices around the world are those who bought overvalued publicly listed technology companies like the Facebook, Amazon, Alphabet(Google previously), Netflix, Tencent, Alibaba etc.

However, recently funding for start-ups have started to dry up. There are signs that the credit tide is reversing slowly but surely.

What do you guys think?

[hailstorm87]

Similar to Specuvestor, I have also read the points raised by Howard Marks and consider them to be quite cogently argued and on point.

That said, I think any discussion of market beating returns without a discussion of risk fails to truly address the issue. This typically brings us to the topic of Alpha (the holy grail of investing). For the experienced investors here who have beaten the market, would you regularly measure your 'Alpha' (i.e. the risk adjusted returns that exceed market returns) ? If so, how do you do so? (the Sharpe ratio comes to mind)

Ultimately, it would be quite meaningless to beat the market by increasing the risk taken. Taking a page out of Howard Marks' thinking:
- index investing involves exposure to market risk (and market returns) - and both downside risk and upside risk are chopped off; and
- (ideally) value investing will involve exposure to market risk and chance on the upside (i.e. market returns + upside returns if the upside event materialises) and downside risk is chopped off.

[weijian]

Investing...is seriously counter intuitive.

What You Can Learn from One of Warren Buffett’s Smartest Investors

The person who helped inspire the passive-investing boom, the late economist Paul Samuelson, became wealthy from his active investments.

The greatest active investor of our time, Warren Buffett, advocates investing passively.

https://outline.com/c3SU4r

[karlmarx]

A timely reminder, in light of the volatile market conditions.

How much time does an active investor spend on managing his/her portfolio, and have returns justified the effort spent?

If all the effort spent by an active investor -- learning how to read financial reports, and then reading financial reports, and then splitting hairs over which securities to buy (or sell), and then agonising over poor market returns -- were to be channel elsewhere, would the active investor be better off?

But would the proposed alternative, passive investing in an index such as the STI, be better off for investors?

If a Singaporean investor bought the STI index since 2010 -- after he is assured that the economy is well on the way to recovery from the 2008 GFC -- he would have seen his portfolio gone now where, except for a 2-3% return p.a. from dividends. Average past returns of 8% p.a. for the STI are often cited as reasons to buy the STI index, but using the actual returns of 2010-2018 would suggest otherwise.

Why are we not seeing 8% p.a. type of returns for STI?

Perhaps STI returns cannot outgrow Singapore's GDP, without an increase in valuation multiple.

If so, perhaps a Singaporean investor who wishes to invest through indices will need to look at higher growth markets -- such as China, Thailand, Vietnam, and Indonesia -- but be exposed to forex risks.

Otherwise, it seems the only way to earn outsized returns from Singapore capital markets is to pick your own stocks and/or (distressed) debt instruments. Or place your money with active managers who have proven able to do so. Unfortunately, non-index-hugging funds which employ strategies for outsized returns are not available to most. So for most, performing your own picks is the only way.

[level13]

  SSRN-id3099723.pdf (Size: 2.16 MB / Downloads: 5)

Why are we not seeing 8% p.a. type of returns for STI?
Or place your money with active managers who have proven able to do so.

The 8-yr period may be too short a time-frame to look at the STI long term return of 8%.

There was a paper that came out in Y2017 (see attachment) which stated that investors should urgently stop relying so heavily on past performance to
choose investments. Performance chasing is a reliable path to poor investment results. High chance that fund managers who do very well in the past 5 years will have mediocre results in the next 5.

[donmihaihai]

A timely reminder, in light of the volatile market conditions.

How much time does an active investor spend on managing his/her portfolio, and have returns justified the effort spent?

If all the effort spent by an active investor -- learning how to read financial reports, and then reading financial reports, and then splitting hairs over which securities to buy (or sell), and then agonising over poor market returns -- were to be channel elsewhere, would the active investor be better off?

But would the proposed alternative, passive investing in an index such as the STI, be better off for investors?

If a Singaporean investor bought the STI index since 2010 -- after he is assured that the economy is well on the way to recovery from the 2008 GFC -- he would have seen his portfolio gone now where, except for a 2-3% return p.a. from dividends. Average past returns of 8% p.a. for the STI are often cited as reasons to buy the STI index, but using the actual returns of 2010-2018 would suggest otherwise.

Why are we not seeing 8% p.a. type of returns for STI?

Perhaps STI returns cannot outgrow Singapore's GDP, without an increase in valuation multiple.

If so, perhaps a Singaporean investor who wishes to invest through indices will need to look at higher growth markets -- such as China, Thailand, Vietnam, and Indonesia -- but be exposed to forex risks.

Otherwise, it seems the only way to earn outsized returns from Singapore capital markets is to pick your own stocks and/or (distressed) debt instruments. Or place your money with active managers who have proven able to do so. Unfortunately, non-index-hugging funds which employ strategies for outsized returns are not available to most. So for most, performing your own picks is the only way.

from your comment and without looking at the chart, I can easily figure out that there is a higher probability for STI 2018 to 2026 return to be way better than 2010- 2018.

chart lie because of the chart person intention!

Weijian
WB make Paul Samuelson super rich. Paul Samuelson profession give him with income, frame and reputation. What does a person need? Does any of the financial economics textbook on EMH put up a note saying, Paul Samuelson got rich by being non EMH?


WB never say one will get super rich by investing in index. 
Anyone interested in why WB say buy index should listen to 2018 agm where CM and WB talk and exchange remarks on indexing. Look like CM think Mungers are smarter than Buffetts and less likely to do stupid things becuase Mungers won't index.

[weii]

A timely reminder, in light of the volatile market conditions.

How much time does an active investor spend on managing his/her portfolio, and have returns justified the effort spent?

If all the effort spent by an active investor -- learning how to read financial reports, and then reading financial reports, and then splitting hairs over which securities to buy (or sell), and then agonising over poor market returns -- were to be channel elsewhere, would the active investor be better off?

But would the proposed alternative, passive investing in an index such as the STI, be better off for investors?

If a Singaporean investor bought the STI index since 2010 -- after he is assured that the economy is well on the way to recovery from the 2008 GFC -- he would have seen his portfolio gone now where, except for a 2-3% return p.a. from dividends. Average past returns of 8% p.a. for the STI are often cited as reasons to buy the STI index, but using the actual returns of 2010-2018 would suggest otherwise.

Why are we not seeing 8% p.a. type of returns for STI?

Perhaps STI returns cannot outgrow Singapore's GDP, without an increase in valuation multiple.

If so, perhaps a Singaporean investor who wishes to invest through indices will need to look at higher growth markets -- such as China, Thailand, Vietnam, and Indonesia -- but be exposed to forex risks.

Otherwise, it seems the only way to earn outsized returns from Singapore capital markets is to pick your own stocks and/or (distressed) debt instruments. Or place your money with active managers who have proven able to do so. Unfortunately, non-index-hugging funds which employ strategies for outsized returns are not available to most. So for most, performing your own picks is the only way.

Investors may like to use Maybank Kim Eng strategy builder to screen for value stocks according to different criteria and do further studies.

[karlmarx]

Why are we not seeing 8% p.a. type of returns for STI?
Or place your money with active managers who have proven able to do so.

The 8-yr period may be too short a time-frame to look at the STI long term return of 8%.

There was a paper that came out in Y2017 (see attachment) which stated that investors should urgently stop relying so heavily on past performance to
choose investments. Performance chasing is a reliable path to poor investment results. High chance that fund managers who do very well in the past 5 years will have mediocre results in the next 5.

1) Whether the 8 year (9 actually) period is too short to determine the long-term returns of STI -- or for that matter, any securities -- I do not have a definite answer. What I do know is that I do not have that many 8-year periods to make wrong bets.

The further we are willing to stretch our time horizon, the higher the probability of higher returns. If we increase the period under our calculation to the next 8 or 16 years, we might see STI reverting to its 8% p.a. returns. Certainly, many Singapore stock investors will be delighted if the market trades at a higher multiple.


2) A fund manager that has outperformed in the past 5 years is more likely to underperform in the next 5 years because of the cyclical nature of the markets. For example, a long-only fund will face difficulty of making (any) returns in 2018 because of the general downtrend in the market.

An investor looking to pick a fund manager has to understand that funds usually outperform during periods of general uplift in the markets. So when I invest in a fund immediately after it has reported huge returns, it means that I am buying during a period when the markets are higher. And as we know, buying when markets are high will result in poorer subsequent results. 

Perhaps a strategy for a fund picker will be to invest in a fund when its short-term historical returns lag its long-term historical returns, by a lot. This assumes that the fund manager is not a one-hit wonder.

If we are to believe that a fund is able to return high returns in the next 5 years after it has done so over the past 5, we must then believe that the fund manager is able to long when the market is at a bottom, and short when the market is at a top, every year. Or, we believe that the fund manager is able to concentrate heavily into those few stocks which turn out to be the year's winners, every year. I don't think either of these expectations are reasonable, and therefore, I don't think it is reasonable for investors to expect high returns to be generated in a linear-ascending fashion.

[karlmarx]

The march of index investing continues. As money continues to pour in, index stocks will continue to be more richly-valued. Could this mean more opportunity for value to emerge from non-index stocks?

https://www.businesstimes.com.sg/compani...g-industry

The other popular/dominant 'style' appears to be investing in REITs, and for good reason. A decade of low interest rates and stable growth has produced very generous returns for numerous REIT investors. As more money pour into REITs this year, could this mean more opportunity for value to emerge from non-REIT stocks?

https://www.businesstimes.com.sg/compani...e-to-shine